Home loan rates set to drop

SRIKALA BHASHYAM, ET BureauNov 9, 2008, 12.00am IST

The expectation of a fall in interest rates always brings hope for borrowers and investors. The good news has been flowing in continuously on the interest front, and the rate cuts announced by banks have even exceeded expectations.

Many banks have already started reversing their lending rates and many have announced a cut of as much as 0.75 percent in their benchmark rate.

This has been slightly higher than the expectations which many had. Prior to the Finance Minister, P Chidambaram's meeting with bankers, the general feeling was that banks might resort to a cut in the region of 0.25-0.5 per cent. The fall in rate has been a result of many factors.

Inflation The rising inflation had forced the central bank to tighten the money supply in the system. As a result, the Reserve Bank of India (RBI) resorted to a combination of cash reserve ratio (CRR) and repo rate hikes.

The moves had their desired effect as liquidity became acute and the global financial crisis added its might with bankers turning extremely cautious with their lending. If retail borrowers were asked to cough up higher margins, corporates were turned away for loans. Expectedly, the interest rate started inching up as less money was being chased by many.

Infusing liquidity Luckily for borrowers, the tough times are on their way out. The RBI itself has been focused on infusing liquidity into the system and has already cut the CRR and repo rates towards this end. The banks' decision to cut benchmark lending rates will further improve the sentiment as interest rates are headed towards the 1-2 year level.

For property loan seekers, this should come as a big relief as they have been the worst affected as EMIs had gone up by a few thousands during the last 12 months. What should borrowers do? Now, for those who are wondering what would be the real benefit from the recent interest rate developments, the answer is simple.

To start with, the benefits would vary from existing borrowers to fresh ones, and even among the existing borrowers the impact would be different for floating and fixed rate products. While most banks have announced a rate cut, including private sector banks, your banker might not push a huge cut.

In such a scenario, borrowers will have to resort to different strategies to take advantage of the current scenario. Here are some tips to make the most of a rate cut: For existing borrowers: Often, a fall in interest rates has been beneficial for the floating rate borrowers rather than for the fixed rate ones, as the interest rate for the latter is linked to the benchmark lending rate.

Now, however, the fixed rate borrowers too can enjoy the dip in the rates as banks have lowered the benchmark prime lending rate (PLR). This will reduce the fixed rate by at least 0.5-0.75 percent, depending on the bank

concerned. This will also reduce the EMI by a couple of thousands and in the case of higher loan amounts (above Rs 25 lakhs), the difference would be significant. If you find that the fixed rate is significantly higher than the floating rate, it is not a bad idea to opt for a switch.

Most banks offer the option of switching from one product to another, and with interest rates having peaked it is not a bad idea to opt for the switch. For floating rate borrowers, it is not such a touch task as this product trails the general interest rate trend.

Hence, you can expect the floating rates to move back to 10-11 percent levels in the next few months. For fresh borrowers: A few months ago, fresh borrowers had the tough task of choosing between the fixed rate and floating rate. Much of the confusion was due to the general uptrend in interest rates which shot up by as much as 3-4 percent in a matter of less than two years.

In the near term, however, the interest rate is unlikely to move up as there is a concerted effort to keep the rates low to push the economic growth rate.

Hence, fresh borrowers can place their bets on the floating rate which is anyway lower than the fixed rate. Also, the floating rate offers additional advantages such as pre-closure without penalty.